Question

1.American Food Services, Inc. leased a packaging machine from Barton and Barton Corporation. Barton and Barton completed construction of the machine on January 1, 2018. The lease agreement for the $4 million (fair value and present value of the lease payments) machine specified four equal payments at the end of each year. The useful life of the machine was expected to be four years with no residual value. Barton and Barton’s implicit interest rate was 10%.

Required:

1. Prepare the journal entry for American Food Services at the beginning of the lease on January 1, 2018.

2. Prepare an amortization schedule for the four-year term of the lease.

3. Prepare the appropriate entries related to the lease on December 31, 2018.

4. Prepare the appropriate entries related to the lease on December 31, 2020.

(Note: You may wish to compare your solution to this exercise with that of E 14–18 which deals with a parallel situation in which the packaging machine was acquired with an installment note.)

Answer 1

1.

Date	Account title and explanation	Debit	Credit
January 1 2018	Right of use asset	4000000
	Lease Payable		4000000
	( To record the right of use asset and lease payable)

2.

PVAF ( 4 YAERS , 10% ) = 3.16987

Annual Lease Payments = Right of Use Asset / ( PVAF ( 4 years , 10% ) ) = $ 4000000 / 3.16987 = $ 1261881

Lease Amortization table for four years

Year	Lease Payments (a)	Effective Interest (10%) ( b = a x 10%)	Decrease in balance (a-b)	Outstanding balance
				4000000
2018	1261881	400000	861881	3138119
2019	1261881	313812	948069	2190050
2020	1261881	219005	1042876	1147174
2021	1261881	114707	1147174	0
Totals	5047524	1047524	4000000

3.

Date	Account title and explanation	Debit	Credit
December 31 2018	Interest Expenses	400000
	Lease Payable	861881
	Cash		1261881
	( To record the first lease payment)
December 31 2018	Amortization Expenses	1000000
	Right of use asset		1000000
	( To record amortization expenses)

4.

Date	Account title and explanation	Debit	Credit
December 31 2020	Interest Expenses	219005
	Lease Payable	1042876
	Cash		1261881
	( To record the first lease payment)
December 31 2020	Amortization Expenses	1000000
	Right of use asset		1000000
	( To record amortization expenses)

Amortization Expenses = Machine lease cost / No. of years = 4000000 / 4 = 1000000